How a 2% increase in price can yield a 20% profit increase



Blog by Peter Macklin, Finance Director, SouthWestfd

 

A company’s pricing strategy is one of the key elements in determining how successful and profitable that company will be.  In simple terms there are three main approaches:

  • Cost-based:  adding a profit element to the costs of purchasing or producing that product
  • Customer-based:  taking a view on what the customer is prepared to pay
  • Competitor-based: where competitor prices are the main influence on the price

In reality most companies will adopt a mixture of all three approaches.  What must never be overlooked though is the impact that a small increase in prices can have.  If we have a company which is making a 40% gross margin and a 10% net margin on a turnover of £1,000,000 then its results will be:

Turnover                £1,000,000

Gross profit           £400,000

Net profit               £100,000

If that company can increase its prices by just 2% then the turnover will go up by £20,000 to £1,020,000 and the net profit will go up by the same amount to £120,000.  In other words a 2% increase in prices has given rise to a 20% increase in net profit!

If on the other hand that same company sells 2% more product but keep prices the same, then if you work through the figures you will see that its net profit goes up to only £108,000, an increase of 8%.  In terms of its effect on net profit, you would need to sell 5% more product in order to have the same effect as a 2% price increase!

In my experience many companies focus on selling more product and don’t concentrate enough on ensuring that small price increases are put into effect wherever possible.  Why not review your price list today and see if there is anything you can do?